Essays on investment, financing, and institutions in China

• Main Author: Lei, Angela Xuying
• Published: London School of Economics and Political Science (University of London) 2012
• Subjects: 332.0951; HG Finance
• Online Access: http://ethos.bl.uk/OrderDetails.do?uin=uk.bl.ethos.571053

China’s unique approach to the market economy during its transitional phase has provoked widespread interest among researchers. While the Western literature can certainly not be directly applied under Chinese economic conditions, it offers important theoretical grounds on which we can build our understanding of different behaviour of firms and banks in China. In the first chapter, we employ a unique set of data on financial information of over 6,000 firms and study the lending pattern of banks in China at a firm level. We find that in addition to common factors such as profitability, size, and credit history, state ownership is highly correlated with banks’ lending decision;the evidence is consistent with the existence of soft budget constraint. The debate over whether such lending bias is caused by the supply side (banks) leads us to the second chapter. We examine and compare investment behaviour of firms under different ownership, with a focus on investment to cash flow sensitivity, using financial and accounting data on over 1,700 listed firms in China. We find opposite effects of cash flow on firms when sample is split between different ownership, with privately owned firms showing a higher sensitivity of investment to cash flow. This result enables us to establish that the cause of lending bias and soft budget constraint in China is indeed a supply side effect. We also find that such sensitivity is positively correlated with firm size and age, but not related to Tobin’q, which we interpret as indicating the lack of market value information about firms in China. Institutional development in the sense of enhancement of the effectiveness of the market is widely viewed as the core to economic reform in transition economies. As privately owned firms generally outperform their state owned counterparts (see Estrin et al. 2009), we study the impact of regional institutions on total factor productivity (TFP) of firms under different ownership. We find that the quality of institutions is highly correlated with firms’ TFP, and that improving institutions to facilitate business operations is crucial for firms to achieve higher effectiveness and sustainable growth. The results also suggest that urgent reform is needed for the state owned sector in China.